Monetary Policy Forum

The Chicago Booth School held its annual Monetary Policy Forum ( Hey they use my book there !) today featured a panel on the Equilibrium Fed Funds Rate. Long time readers know this is a topic near and dear to me, as I have been a vocal anti-Taylor Rule instigator and have had my own "model" since the early 1990's.

Steven Beckner summarized the panel views in a long BBG piece earlier today. The key take away being:  "If the "equilibrium" interest rate has fallen somewhat,the Federal Reserve might need to delay raising interest rates, but if it does the Fed will likely need to raise rates "more steeply" later."

The panel disputed the Larry Summers' promulgated view of a secular decline in growth rates. Here's my view from the Left Coast:

Skipping past the math that led to my neutral rate calculation, a simple way to consider my view goes like this - If you start to build from the FF rate you don't get "clean" feedback because the first input may not be in the "appropriate" place. ( The Taylor Rule is built on inputs that are subject to huge revision and time delay making it useless from a policy steering standpoint.) Thus, I use a rate that is influenced both by the Fed's present rate stance AND market participant pricing -  12 month LIBOR. [ IMPORTANT: These metrics assume a return to a Rate Regime - a primary orientation NOT yet achieved by the Fed.]

So, looking at just the recent past, we see:

This date last year; .56

Last month: .62

Today ; .67 ---

Subtract the constant of 60 bp and voila, you have the Equilibrium Funds Rate or, roughly the prevailing rate 7-12. (smart guys like @groditi can build you all sorts of cool graphs if you ask nicely) Point of parliamentary procedure - By equilibrium we mean the rate at which the Fed stance is neither stimulating nor inhibiting growth. The "neutral" rate, a monetary policy maker's nirvana. In our brief snapshot we can determine that the Fed was "assisting" the negative neutral rate with LSAP. As the rate adjusted up, (no change to official FF rate) policymakers tapered the buying. As we've stated numerous times prior, contrary to popular delusion, the Fed was not/ nor could be as aggressively stimulative as many concluded simply because the official rate was "ZIRP." In a post credit super cycle burst, the equilibrium rate fell to zero/negative. Despite heated ranting from famous detractors, if the market was left to determine the rate it would have eventually found the zero bound, according to our work.

Suspending your disbelief for a second, I would pose this question: Given the prevailing "Neutral Stance" and the observable data inputs (inputs that as a cluster support the equilibrium view btw- moderate growth/ low inflation) Why should the Fed need/want to raise the rate? In fact, despite all the jawboning, if the Fed were to act under the present term structure, we would deem the action PREEMPTIVE. With debt deflation still a real concern for much of the developed world, preemptive rate hikes seem dangerous to us. The long lead time to action is a function of the market's inability to adjust away from ZLB as much as policy makers FG promises- which have faded without violent market rate upward adjustments.

Conclusion: The Fed has time to wait on raising the rate because Mr Market says so. When/if the market rate is able to stretch from the ZLB, the then "behind" Fed stance will become temporarily MORE stimulative, advancing late cycle positive consequences suggested by @ivantheK in yesterday's stream. (Example: 12 month rate rises to 100bp on improving outlook and Fed official rate moves to 25 -50 window. Market prices middle at .37 -still pretty neutral (100 - 60 = 40) ! If 12 month money continues to rise, a big if given the world, the pace and strength of Fed adjustments should adjust accordingly behind it.



One thought on “Monetary Policy Forum

  1. Sean

    Beautiful deconstruction and rebuilding of the issue. If you had to handicap what they will do? I agree with your assessment wholeheartedly, but I feel they complicated the matter with your other point about too much transparency.


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